Move over infrastructure week. On Capitol Hill, it’s ESG month!
It’s hard for me, too, to contain my excitement. Environmental, social and governance issues for the whole month of July. It’s like Pride, Black History, International Women’s Day, and Christmas rolled into one. There aren’t enough smiley emojis to express my joy.
To recap: Republicans are frothing at the mouth because woke capitalism is running amok, damaging the retail investor, to Republicans the only right and proper shareholders to whom corporations should accountable.
Further, the only things corporations should be providing to these shareholders are – to channel our former President – huge, beautiful profits. Profits that will be damaged if corporations start worrying about things like climate change, diversity, or, heaven forbid, LBGTQ+ rights.
To hear the Freedom Caucus and other members of the GOP tell it, irresponsible institutional investors are forcing damaging woke ESG agendas on corporations at the cost of good Fox News-watching, stock-holding, pension-having Americans. They are aided in the quest by mistake-prone proxy advisors and Wall Street firms that love to hurt Main Street America through their devotion to such profit-sucking causes as climate change and human rights.
Republicans are being – you might want to sit down for this – disingenuous. The hearings simply have provided a new forum in which to play out their culture wars, rally the base, and fundraise for the rigorous election season ahead.
And the package of anti-ESG legislation submitted this month by GOP members of the House isn’t going anywhere. None of these bills will ever pass the Senate; if they did, they would be vetoed by the White House. Indeed, the first bill President Biden ever vetoed was a piece of anti-ESG legislation.
So yes, let’s defend ESG. But let’s also acknowledge that ESG on its own is not going to change much. Pretending otherwise just kicks the can down the road. It’s time to start asking the hard questions and push for much much more.
The left has predictably, if belatedly, rallied to the support of ESG. Activist groups and other stakeholders are extolling the virtues of ESG, shareholder engagement, and governance, while pointing to the toll that anti-ESG legislation is taking on states that have passed laws to restrict ESG investment by pension plan, treasury departments and other state institutions.
Politico reports that the Progressive State Leaders Committee “is partnering with the Horizon Project to establish a responsible investment working group to highlight the roles of attorneys general, state treasurers, comptrollers and auditors in protecting pensioners’ returns and interests.” The plan to push back against the anti-ESG efforts comes with a six-figure spending campaign, according to Politico.
But listen to the whispers: What if corporate engagement isn’t really very effective at all?
For decades the primary tool that investors have used to engage with companies and force changes to behavior with regards to what we now call ESG has been proxy voting, shareholder resolutions, and shareholder engagement. Sometimes those campaigns are successful – see below re: hedge fund manager Engine No. 1’s 2021 proxy campaign against energy giant Exxon – but often they are not. Even when they, say, get a company to produce a climate change report, the victory is often pyrrhic.
Company that ticks a lot of corporate governance boxes, like Seattle-based Starbucks, can fail in significant ways. In Starbucks’ case, the business is caught in a fight with the National Labor Relations Board over contract negotiations for unionized employees. Questions have been raised over the company’s willingness to let employees unionize, causing some investors to call for the company to account for its behavior toward union friendly employees.
Over the past decade, the tone at the top of many, if not all, Fortune 500 companies has changed. Maybe it’s possible to attribute some of that change to shareholder engagement. But, far more likely, it is the result of a broader cultural shift involving multiple stakeholders including consumers, workers and policymakers along with activists.
A certain sector of the impact investment community likes to hate on ESG for not going far enough, for abetting corporate greenwashing, for providing cover for big business, and more. I do think the earnest people at the Council for Institutional Investors and all those important ESG people running around at asset management businesses are doing something. But the scale of the problems we still have to tackle is so great that I don’t think shareholder engagement is enough.
Corporate engagement and shareholder action is not materially moving the needle in terms of where we are as a society and an economy.
Rather than worrying about small-bore governance issues like proxy access, we should spend more time thinking about how to really drive capital to where it’s needed most, and ensure that the planet and everything on it is getting better, not worse. What is the point of long-term investing if there is no long term to invest for? We’re running out of time.
We need a radical reset that pushes us beyond the relative comfort zone of corporate ESG and, rather, requires us to ask harder questions around what we are really doing to insure the long term sustainable health of not only our investments but our communities and the planet.
At some point we have to recognize we can’t have our cake and eat it, too. We can’t have unchecked growth, and protect people and the planet. This is where impact investing arguably has an edge over ESG, because impact requires that we look at the total impact that an investment, or a business, has on a community, the environment, and the economy.
This work is hard, and it is unlikely and unhelpful for investors to have to think through every consequence of their actions. But we can not and should not, for example, continue to live in a world where teachers can not afford houses or rent because their own pension plans have bought up all of the available housing stock.
Arguably we need a more holistic notion of fiduciary duty, one that looks at the entire impact of a portfolio or an investment rather than only the bottom line profit. The fact that half of the political establishment thinks that even asking companies about climate change is a bridge too far makes it unlikely that we will be revisiting the question of fiduciary duty in anything like a sensible manner any time soon.
At the end of the day, it won’t matter if the GOP doesn’t want to believe in climate change, because Europe is going to move ahead with ESG regulations on corporations, and that will have a global impact on any company that wants to operate outside the U.S. borders, and Miami will be underwater.
Just like with the ridiculous regressive nonsense coming out of the Supreme Court these days, the GOP’s grandstanding on this issue is holding the U.S. economy back and hurting people along the way.
The House hearings are mostly about political showmanship and clips for the Fox News sizzle reel. But if the radical right of the GOP gains more power in the 2024 election, we can all expect a further ratcheting up of what is ultimately economic, social, and enviromental suicide. All in the name of protecting real Americans, the retail investors of Main Street America who just want what is owed to them: sweet, sweet profits.
What has gotten me thinking about the effectiveness of corporate engagement is not the antics of the GOP, but rather the two-year anniversary at the end of May of then-hedge fund manager Engine No. 1’s successful shareholder campaign against ExxonMobil.
As everyone remembers, in 2021 the newly formed hedge fund firm Engine No. 1 launched a proxy campaign against Exxon, the Goliath to its David, offering its own slate of board members and requesting various changes in business behavior with the intention of repositioning the energy company in response to climate change.
To the surprise of practically the entire industry, the campaign was wildly successful. Engine No. 1 got three of its four proposed candidates onto the board, having secured crucial backing from important institutional investors such as the California Teachers Employees Retirement System (CalSTRS) and the Church of England Pension Plan. The two largest proxy advisors supported at least two of four of the hedge fund’s board nominees. And, in the end, the big three major mutual fund managers, BlackRock, State Street and Vanguard voted shares in support of at least some of Engine No. 1’s nominees.
So what has actually changed at Exxon?
Yes, the company is talking much more about climate change, and talking a big game with regards to carbon capture and recycling.
But, Exxon is still paying a dividend of $0.91 a share, higher than its November 2021 payment of $0.88 a share. Reducing the dividend and maintaining capital allocation discipline was a key part of Engine No. 1’s campaign. In December, Exxon announced plans for as much as $25 billion of capital spending in 2023, up 9% on 2022, with plans to keep oil production steady at 3.7 million barrels a day (assuming Brent oil prices are at least $60 per barrel).
Moreover, the energy company posted a record year in 2022 with profits of $56 billion, a historic high. Production was up by approximately 100,000 barrels of oil and gas a day. Meanwhile the oil major continues to fight activists who want it to do more, even denying that the world will reach net zero global emissions by 2050.
As an investment, Engine No. 1’s Exxon trade was successful. The stock is up considerably from where it was in early 2001. In terms of furthering the ESG agenda, shareholder activists’ biggest-ever victory was effectively a nothing-burger.
It’s hard to escape the feeling that what Engine No. 1 mostly did was put some nice people on Exxon’s board, who now get to earn between $220,000 and $266,000 a year for advising an oil and gas major.
A bomb under the GOP
What Engine No. 1’s victory over Exxon did do was change the conversation around ESG. Suddenly a little hedge fund, out of the heart of Wall Street and Silicon Valley, could take on a blue chip company, using the language of ESG to do it. It also put a bomb under the GOP establishment, helping cause the current ESG backlash that we are seeing at both the federal and local level.
The backlash was already under way before Engine No. 1 was even launched, but the fact that such a large and established company as Exxon could be vulnerable to an ESG activism campaign was a huge shock to the system. It is no coincidence that Texas, home to Exxon, is one of the states leading the charge on anti-ESG legislation. And oil and gas companies are among those bankrolling anti-ESG efforts.
Which brings us back to Washington.
I watched the first round of ESG hearings on Capitol Hill last week (so you didn’t have to). The only silver lining: Jim Jordan and Matt Gaetz were off bullying the Trump-appointed head of the FBI at a different hearing. Having yet to find their way onto the House Committee on Financial Services, they were unable to bring their toxic brand of hyper-bro politicking to the debate.
Also promising: Some Democratic representatives made a sometimes surprisingly thoughtful case for ESG and stakeholder engagement. Rep. Sean Casten (D.-Ill.) lampooned Republicans for not supporting capitalism and the free market economy but rather trying to protect the interests of big oil and other special interest groups.
“The party of Ronald Reagan, the party of Milton Friedman is afraid to defend capitalism. You all ought to be ashamed of yourself,” he scolded. “And if it is partisan to support free markets and defend investor rights, let’s double down on the partisanship because it is the only way we move forward as a country.”
To be fair, not all Republican arguments in this discussion are nonsensical or disingenuous. Proxy voting advisors do hold a lot of power. And SEC climate regulations will require greater disclosure, which may indeed be burdensome to some businesses. Left-wing shareholder activism can and still does target things that might be important to civil society (human rights, for example) but are nonmaterial to business, and may even negatively impact profitably (good luck making iPhones without Foxconn).
But the Republican members of the House Financial Services committee, and the witnesses they brought in to testify, were mostly coming at the question of ESG from an outdated, backward-looking notion that suggests these factors are non-material and that caring about them is a drag on corporate performance and profit.
What ESG is focused on, when it works well, is the material financial risks that come from governance, social, and environmental issues.
These risks are not tiddlywinks. We are not focused on them for the warm and fuzzies, or just because we think it’d be just dandy if corporations were better to people. An even sharper focus on material factors like climate change and addressing discrimination is required to force companies, investors, and society at large to get the big things right. So, to echo Rep. Casten’s point, society can continue to progress forward.
I’m sorry that it’s hard. I’m sorry that not all important issues can be easily tracked on a balance sheet or put in a box. But that doesn’t mean they are not real. Or that they are not going to have real consequences for businesses, investors – and the rest of us.